Tesla Stock: Why We Aren’t Buying The Rally (NASDAQ:TSLA)

Critics will rightly point out that since several Tesla models skew to the more premium side of things, that a whole-batch count of insurance registrations likely doesn’t tell the whole picture.

However, the Model 3, which retails for below 300,000 RMB in China, is not considered to be a high-end sedan. Here are the monthly figures for January’s total registrations.

In January, the best-selling non-premium EV sedans in china were: the BYD Dolphin with 17,582 registrations, the Hongguang Mini EV with 16,416, the BYD Qin with 14,185, followed by the Tesla Model 3 with 12,659.

A typical bull argument for Tesla’s market-lagging position behind BYD (OTCPK:BYDDY) is that Tesla typically runs at a higher price point. The Model 3, however, competes at a more mass-scale price point than the Y or S, so we would expect that sales there would be more indicative of Tesla’s mass appeal within China.

A Risky Road Ahead?

Tesla’s latest 10-K release provided us with an opportunity to review changes to its risk factor disclosures. This section of a company’s SEC filings are often dismissed by investors as boilerplate or unimportant, but we believe that attitude to be a mistake.

While some risk factors certainly are boilerplate, the language surrounding them is typically fraught with internal debate at a company. Occasionally, very important disclosures and changes to prior risk assessments are made, and so we believe that scanning company filings for changes in risks is a good use of investor’s time.

Here are a few risks that were added to Tesla’s disclosures in its recent 10-K filing which were absent from 2021’s 10-K.

Warranty Coverage

Our current and future warranty reserves may be insufficient to cover future warranty claims. [p.22]

This is, in our opinion, anything but boilerplate. Warranty claims can quickly eat into a company’s bottom line, and if they are not budgeted for correctly, can be hefty.

We believe Tesla’s warranty risk to be quite high. The National Highway Transportation Safety Administration keeps a log of vehicle recalls as well as consumer complaints about vehicle safety and performance. The Tesla 2022 Model 3 listing posts 9 recalls, 4 investigations, and 469 submitted complaints.

Of course, these ratings can’t be assessed in a vacuum. To that end, we looked up a 2022 Honda Accord, which, despite being an ICE vehicle, is similar in size and cost. That vehicle’s page has 0 recalls, 0 investigation, and 25 complaints.

For a more apples-to-apples EV comparison, the 2022 Hyundai Ioniq SUV has 1 recall, 1 investigation, and 18 complaints. (For the record we selected 2022 models to allow for more market time.

When you compare the 2022 sales data, this works out to 1 complaint for every 6,184 Honda Accords sold, 1,276 Hyundai Ioniq SUVs sold, and every 512 Tesla Model 3s sold. This is, to put it mildly, a pretty large statistical variance.

At least a portion of these complaints have the ability to be converted into warranty claims, and we think that the disclosure about warranty accounting is important in light of the volume of complaints received by the NHTSA.

Further Tesla Stock Sales?

If Elon Musk were forced to sell shares of our common stock, either that he has pledged to secure certain personal loan obligations, or in satisfaction of other obligations, such sales could cause our stock price to decline. [p.28]

Following the purchase of Twitter, Elon Musk publicly pledged to not sell any more Tesla stock for roughly two years. However, this new disclosure in Tesla’s 10-K does not have any timeline stipulation. The disclosure covers the fact that Elon Musk has pledged a certain amount of Tesla shares as collateral to banking institutions.

All of this is well known. However, it’s the last sentence of the disclosure that we’d like to focus on. It reads:

Further, Mr. Musk from time to time may commit to investing in significant business or other ventures, and as a result, be required to sell shares of our common stock in satisfaction of such commitments.

While Elon Musk has pledged publicly that he will hold off for a certain amount of time, this new disclosure does not subject his sales to any time frame – indeed, it appears to be up to his discretion.

What’s The Takeaway?

As we assess whether the rally in Tesla stock is warranted, we have turned to the figures and operations of Tesla in China and come away with a few questions. What we want to know, ultimately, is whether or not our question about high demand versus production capacity was limited to January – i.e., a completely normal disruption of the supply-demand relationship due to the Chinese New Year.

Second, with Tesla for now shuttering its plans to expand production capacity at its Shanghai factory, is the current demand for the company’s vehicles at a near-term peak? These are questions that we hope to have answered on the next earnings call.

Lastly, a review of recent risks added to the 10-K give us some new contours with which to assess Tesla. The fact that the company is thinking about its warranty reserves and has disclosed that its warranty coverage may not be sufficient under certain circumstances, should at least be something investors are aware of. This disclosure, combined with the comparably high level of NHTSA complaints, puts our antennae up about possibly rising warranty claims just over the financial horizon.

So, given that the current rally seems to have been sparked by excessive optimism following the last earnings call, we have concerns that the rally is unsustainable and could snap back on investors quickly should negative news emerge. For now, these questions are enough for us to remain on the sidelines when it comes to Tesla.

Editor’s Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.